My understanding of MMT - Please point out any errors

[Gumby]

It's also worth pointing out that there are two aspects of MMT: descriptive and prescriptive.

The descriptive fundamentals of MMT just describes the operational reality of how a fiat government avoids solvency issues.

The prescriptive side of MMT are theoretical ideas for how to maximize productive output of a fiat nation (a "Job Guarantee" for instance). MMT's prescriptive ideas are untested and unproven. You don't need to agree with the prescriptive side of MMT to understand the descriptive side of MMT. You may even develop your own prescriptions based on your understanding of the descriptive side of MMT.

Every monetary system has a "buffer stock policy" that helps a government control its spending. A buffer stock policy can be based on Gold, Wheat, etc. In other words, if you run out of gold, or wheat, you just issue some debt and borrow what you need to keep your currency convertible into wheat or gold. Gold was preferable until it became too limiting (for every government on the planet). MMTers just prefer "employment" as their buffer stock policy. It's believed to be a more modern approach to maximizing the productive output of a nation, while keeping inflation under control.

Remember, before Keynes, economists used to believe that inflation was a function of nothing more than the quantity of money in existence. Keynes disproved the Quantity of Money Theory by proving that other factors were just as important in determining inflation (such as employment, as well as the demand and the velocity of money). All mainstream economists now understand that inflation is more complex than simply the amount of money in existence.

[Gumby]

Thanks for the clear, simple explanations, Gumby! So, in your table, it looks like this $100 deposit turned into $457.04 (89.25 in reserves at banks, 357.05 loaned out, and 10.74 final deposit). And even if the multiplier were 3, the banks created the money didn't they, depending on how much was "loaned into existence?" Yet the M0 is "spent into existence" by government. How are these connected?

Yes, banks do create money out of thin air. But, not much. And they all must be paid back and net to zero. Nevertheless, consider that the M1 multiplier has rarely ever been above 3.

http://research.stlouisfed.org/fred2/graph/?g=4ty

The multiplier is currently below 1, which means that the money multiplier is dead in the water (i.e. any number times anything less than 1 equals an even smaller number).

M2, and higher, also consists of "close substitutes for money" (such as commercial paper in money market funds). These higher M's can be backed by all sorts of things (think 'shadow banking', etc).

The Treasury will only collect M0 for tax payments or for payments when purchasing Treasuries (via a bank's reserve account held at the Fed). In other words, you can't buy Treasuries or pay your taxes with loans or commercial paper — the Treasury just won't accept it. So, private bank loans are inconsequential when it comes to the money we give back to the Treasury.

[brick-house]

gumby wrote

It's also worth pointing out that there are two aspects of MMT: descriptive and prescriptive.

The descriptive fundamentals of MMT just describes the operational reality of how a fiat government avoids solvency issues.

Very helpful distinction.  I am understanding the descriptive part of MMT.  However, I think the prescriptive form underestimates the corruption and cronyism involved in selecting the who, when, what, and how much of government spending.  This can lead to mal-investment and inflation.  Oh well, my head hurts - Too much dismal science thought for a low level employee in sector g.  

[Gumby]

I think the prescriptive form underestimates the corruption and cronyism involved in selecting the who, when, what, and how much of government spending.  This can lead to mal-investment and inflation.

I agree 1000%. But, again, this is true of any economic framework.

Perhaps it just seems scarier when a government isn't reserve constrained. Though, on the other hand, European nations are reserve constrained (since they don't issue their own currency), and that's a very scary situation.

[Gumby]

With the car analogy, what if stepping on the gas more and more generates less and less net effect (due to wind resistance, etc.), and you eventually run out of gas before the destination?

I think I understand what you are saying. Here are the golden MMT rules....

• A government must be the sole-issuer of its currency. (Eurozone nations fail this test)
• A government must not owe any foreign-denominated debt. (Weimar Germany failed this test)
• A government must have a free-floating currency. (currencies with pegs and/or a set convertibility fail this test)

If a government can pass these tests, it's pretty much impossible for it to run out of gas. But, headwinds and bumpy roads are going to be a challenge for any economic framework. And bad political decisions will crash any car.

In the case of spending and debt, can't an economy spend so much and accumulate so much debt that the interest on the debt becomes too large a percentage of spending, dragging down the whole system?

Excellent question. Yes, it is possible to spend too much. Zimbabwe is a good example of that. Zimbabwe had civil unrest that dropped their productive capacity by about 80% while government spending stayed high — and too much spending power with too few goods and services for sale drove prices through the roof.

But, keep in mind that a fiat government will never have trouble paying its bills. And, if interest payments become an issue, a fiat government has the ability to drop interest rates to zero, eliminate its debt entirely, or stop issuing debt altogether. For instance, Warren Mosler has suggested that the Fed just set short term interest rates at zero and just have the Treasury stop issuing Treasuries that are longer than 90 days.

[brick-house]

gumby wrote

But, keep in mind that a fiat government will never have trouble paying its bills. And, if interest payments become an issue, a fiat government has the ability to drop interest rates to zero, eliminate its debt entirely, or stop issuing debt altogether. For instance, Warren Mosler has suggested that the Fed just set short term interest rates at zero and just have the Treasury stop issuing Treasuries that are longer than 90 days.

What if there is no demand or slack demand for the Treasuries at zero interest rates or certain maturities?  What if U.S. citizens started holding gold or foreign currencies instead of U.S. dollars?  According to MMT, is there a point where there is too much debt? 

[Gumby]

What if there is no demand or slack demand for the Treasuries at zero interest rates or certain maturities?

The Primary Dealers are obligated to provide a market for Treasuries — it's in their contract. That's what they do. Also, there is always a demand for risk-free assets. Many funds are required to hold risk-free assets. Furthermore, when the government spends money, it creates excess reserves for banks. When banks have too many reserves, they actually want to give it back to the Treasury for safekeeping. So, this alone is one reason why large banks sign up to be Primary Dealers in the first place — so they have an easy way to drain their excess reserves.

What if U.S. citizens started holding gold or foreign currencies instead of U.S. dollars?

Highly unlikely. The reason is stamped right on our currency: "This Note is Legal Tender for All Debts, Public and Private". The key word here being "Public". Dollars are the only currency that the government will accept for paying taxes. People go to jail if they don't pay their taxes in US dollars. This alone gives the dollar value as a currency and causes people to actually want dollars as payment. This isn't a new phenomenon. In the middle ages, you had to pay your king taxes with his own coins, or risk death or imprisonment if you refused. Those coins would often have less value outside of his kingdom (usually closer to the value of the metallic content of the coins).

Also, when people exchange their dollars for gold or foreign currency, those dollars still have to exist in a US bank. Even the Chinese have to hold their US dollar assets in the US banking system. (Foreign governments, such as China, actually have special bank accounts at the Fed to hold their dollar assets). It's not like dollars are extinguished or destroyed because someone exchanges them for gold or foreign currencies. And when banks have excess reserves, they trade those reserves for Treasuries.

According to MMT, is there a point where there is too much debt?

You'll have an easier time grasping all this if you just think of our "debt" as just a form of fiat money printing. I mean, I don't anyone can logically say that we are a fiat country that needs to borrow money and collect revenues to pay its bills. It doesn't make any sense. That would be like a scorekeeper borrowing and collecting points to finish every game.

But, the answer to your question is... Yes. When full-emplyment is reached, the government needs to cut back on spending and/or raise taxes. Otherwise it would cause inflation. When people start having too much disposable income and businesses are unable to hire new workers to meet that extra demand for goods, it causes prices to rise. And real data from the Fed shows us that there is a very strong correlation between the rate of change in disposable income and the inflation rate.

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If you haven't watched the video I mentioned earlier in this thread, you should really try to watch it.

http://modernmoney.wordpress.com/2011/1 ... is-simple/

Finally, it's important to realize that the descriptive fundamentals of MMT are apolitical. There are conservatives who understand MMT and there are liberals who understand MMT. What you choose to do or prescribe using MMT's descriptive knowledge is entirely up to you.

Hope that helps... Good night!

[stone]

What if there is no demand or slack demand for the Treasuries at zero interest rates or certain maturities?  What if U.S. citizens started holding gold or foreign currencies instead of U.S. dollars?  According to MMT, is there a point where there is too much debt? 

I think the key point is that someone always has to be left holding any of the monetary base that is out there. If the public wants to hold gold more than they want to hold monetary base, then the monetary base will get tossed back and forth like a hot potato as the price of gold gets bid up but that wont make the monetary base go away. Same thing is people want to hold say Mexican Pesetas rather than USD. They will toss the USD back and forth bidding up the value of the Mexican currency but the USD will still be out there held by someone.

The normal thing that people want to hold if they have an excess of USD base money is US treasuries. So they toss the USD back and forth bidding up the price of the treasuries. That is why lots of monetary base means low interest rates under our system.

[brick-house]

gumby wrote

You'll have an easier time grasping all this if you just think of our "debt" as just a form of fiat money printing. I mean, I don't anyone can logically say that we are a fiat country that needs to borrow money and collect revenues to pay its bills. It doesn't make any sense. That would be like a scorekeeper borrowing and collecting points to finish every game.

Uh, gee thanks perfessor...  I grasp this just fine, I understand the descriptive part.  Again, I disagree with the prescriptive part.  Believe it or not, there are scores of economist who share my concerns. 

[stone]

Gumby, do you agree with the perpetual spending over and above taxation prescriptive part?

[MachineGhost]

Remember, before Keynes, economists used to believe that inflation was a function of nothing more than the quantity of money in existence. Keynes disproved the Quantity of Money Theory by proving that other factors were just as important in determining inflation (such as employment, as well as the demand and the velocity of money). All mainstream economists now understand that inflation is more complex than simply the amount of money in existence.

Just as a reminder:

Inflation = Government Spending + Change in Velocity - Output Growth.

Essentially, when spending is higher than the demand for money in relation to the productive capacity of the economy, the excess money created is what raises prices as people realize the currency has been devalued.  Supply side shocks or capacity constraints/underutilization are rolled into Output Growth but a better formula would break down those factors for clarity.

How many members of Congress understand this equation?  I won't hold my breath.

MG

[Gumby]

gumby wrote

You'll have an easier time grasping all this if you just think of our "debt" as just a form of fiat money printing. I mean, I don't anyone can logically say that we are a fiat country that needs to borrow money and collect revenues to pay its bills. It doesn't make any sense. That would be like a scorekeeper borrowing and collecting points to finish every game.

Uh, gee thanks perfessor...   I grasp this just fine, I understand the descriptive part.  Again, I disagree with the prescriptive part.  Believe it or not, there are scores of economist who share my concerns. 

No need to be a smart ass. You asked the question. I just answered it as best I could. It takes most people months to understand the descriptive part of MMT (Fed/Treasury operations, private sector, net financial assets, bond auctions, primary dealers, etc). And we haven't even begun talking about the prescriptive side of MMT yet, so I don't know how you can say you disagree with it. We've only been focussing on the descriptive part here. And, by the way, any economist who thinks that US Treasury Bond auctions are going to fail from us having too much debt, or US citizens wanting to hold gold or foreign currencies, or us being downgraded, doesn't understand the mechanics of how a fiat government works — with the Fed and Treasury being able to fund its own bond auctions with its own government spending.

[MachineGhost]

Uh, gee thanks perfessor...   I grasp this just fine, I understand the descriptive part.  Again, I disagree with the prescriptive part.  Believe it or not, there are scores of economist who share my concerns.  

There is no way to know for sure whether the MMT prescriptions will actually work or not without first trying them.  It's not like warfare or other criminal behavior is being recommended.  At best we'd eliminate injustices, inequalities and mitigate the effects of the business cycle, at worse we'll just waste some of a never ending supply of money.  It seems to me theres very little downside in trying.  Besides, whats the plan for dealing with the losers of current society (the disabled, ex-convicts, long term unemployed, old people, etc). under our current regime where scores of economists and politicians think the national debt is a constraint and isn't reflecting private sector savings?  Those losers are not something to sweep under the rug and ignore just because they are an inconvenient exclaimation point to ideaology.

MG

[Gumby]

Gumby, do you agree with the perpetual spending over and above taxation prescriptive part?

Yes. If people are unemployed, and willing to work, there's no reason why everyone who has a job in the private sector should have to fully fund the unemployed out of their own salaries (or assets) if bridges, police stations, military bases, and schools need to be built and fully staffed by a fiat government. That wouldn't be very fair to the employed and it would stifle growth.

Furthermore, the interest payments on every private bank loan tends to cause the money supply to need to grow. And as the money supply grows it requires more government spending than taxation and it becomes a never-ending loop to keep up with the interest payments on private loans. It's the never-ending private interest payments and growing population that tends to grow the money supply.

Stone, a few days ago, Moda and I asked you your opinion about how private interest payments often requires money that does not yet exist in the private sector — particularly when the economy slows, and creditors aren't spending loan payments back into the economy. We explained how this leads to larger deficits, with interest payments, that create a never-ending loop of deficits. You said...

The most important point IMO is that nominal growth of the economy is neither necessary nor sufficient for prosperity/real economic growth. There could be only one remaining USD. Technology could have improved in leaps and bounds. We could all be tended by robots, flying around on hoverboards or tele-porting or whatever and all transactions could be conducted in units of one trillionth of a dollar.

When I read that, it implies that you would rather see perpetual deflation than low inflation. Politicians get reelected when they provide nominal growth. A nominal loss on people's houses and investments does incredible damage to the psyche of a nation and its spending habits. People want nominal growth and stable prices, not ever-shrinking micro-dollar transactions.

[stone]

Gumby, everyone seems delighted to me whenever they see prices fall in a sale or whatever. I was delighted on Saturday to see that crusty brown loaves were now 72p rather than 75p. I don't see people wringing their hands about computor prices falling as they do. I'm just advocating a system that reflects reality rather than using smoke and mirror trickery as a political expedient/ means of fraud. You say that spending more than taxation is a way to avoid having private sector workers needing to pay for what the government directs to be done. I think that that is a very simplistic interpretation. Nominal wages do get devalued by pumping more USD out. The fact that we do not see deflation despite improvements in technology etc is simply down to devaluation of all of our wages. Things are actually worse than that because of the waste that comes from the economy becoming corrupted into simply being a machine for harvesting the effects government debt expansion rather than the economy delivering what people actually need and want.

[brick-house]

gumby wrote: 

No need to be a smart ass

Lighten up, perfessor...  Sharp elbows and thin skin is not a good combo. 

gumby wrote:

It takes most people months to understand the descriptive part of MMT (Fed/Treasury operations, private sector, net financial assets, bond auctions, primary dealers, etc). And we haven't even begun talking about the prescriptive side of MMT yet, so I don't know how you can say you disagree with it. We've only been focussing on the descriptive part here.

You seem to think that this thread is the only source about the descriptive and prescriptive parts of MMT.  Believe or not, there are lots of sources about Modern Monetary Theory.  Some of the sources are cheerleaders and some are skeptics.    I agree with the skeptics. 

gumby wrote: 

And, by the way, any economist who thinks that US Treasury Bond auctions are going to fail from us having too much debt, or US citizens wanting to hold gold or foreign currencies, or us being downgraded, doesn't understand the mechanics of how a fiat government works — with the Fed and Treasury being able to fund its own bond auctions with its own government spending.

Wow.  Any economist who disagrees with you doesn't understand the "mechanics".  Are there gears in the fiat economy? 

[Gumby]

Stone, no one is delighted when they see the value of their home falling and they have interest payments on a mortgage for a higher value. Deflation sucks. Don't pretend that doesn't damage people's spending habits. It's a huge problem.

[stone]

Gumby, just to clarify, I think genuine price honesty is ideal not that run away deflation is ideal. To my mind the ideal might be if the USD (or GDP or whatever) was  defined as being a certain proportion of each government employee's wage (eg so much for a new army recruit, so much for a five star general, so much for a supreme court judge etc). Then hopefully efficiency gains/new technology etc would mean that as the decades went by, they would be able to buy more with that wage.

[stone]

Gumby, when you say deflation sucks I guess you mean having debt repayments grow faster than your ability to pay them off sucks. It does. I don't think an expanding monetary system is the way to tackle that issue. The only reason why people face such a debt burden is because monetary expansion bamboozled people into creating debt fueled asset bubbles. Unless you are advocating an accelerating rate of inflation for house prices zooming off to ever new multiples of peoples wages you are going to bump into that issue. Price stability would mean that people would only buy houses that they could afford and that would put a ceiling on prices. Germany and Switzerland had stable house prices. They now don't have a housing crisis.

[Gumby]

Lighten up, perfessor...  Sharp elbows and thin skin is not a good combo.

What's with the "perfessor" shtick? You claim to be clueless about MMT and say things like...

Totally confused by MMT.  I understand Ancient Alien Astronaut Theory better.  Some questions:

What is the proper amount of spending?  
How is that determined?  
How is that corrupted by lobbyists?
What are the consequences of spending the incorrect amount every year?  
So is the current deficit, the 15 trillion in debt, plus the unfunded liabilities of social security and medicare - a problem or nothing to worry about?

...and then you chastise me for trying to help you understand your own questions? Nice.

I agree with the skeptics.

Seems like you might want to become less "confused by MMT" before you decide whose side to back.

And, by the way, any economist who thinks that US Treasury Bond auctions are going to fail from us having too much debt, or US citizens wanting to hold gold or foreign currencies, or us being downgraded, doesn't understand the mechanics of how a fiat government works — with the Fed and Treasury being able to fund its own bond auctions with its own government spending.

Wow.  Any economist who disagrees with you doesn't understand the "mechanics".  Are there gears in the fiat economy?  

It's true. Our government's bond auctions are designed not to fail. The Treasury never holds a bond auction unless the Fed confirms that the reserves from government spending are in place first. That's why Primary Dealers always oversubscribe the bond auctions by more than 2:1 every time. What else do you want me to tell you?

Most economists were taught from textbooks that were written during the Gold Standard era, when we could run out of money. The textbooks never changed once we went fiat. I can't help it if economists are still applying reserve-constraints where none exist. Keynesians believes our government needs to have surpluses during good times so that it can "save" enough for deficits during bad times. How does a fiat government meaningfully "save" money that it creates out of thin air? It's nonsensical.

I'm sorry if you think I'm lecturing you, but you asked the questions and I just answered them. If you don't want an answer to your questions, don't ask!

[Gumby]

Gumby, when you say deflation sucks I guess you mean having debt repayments grow faster than your ability to pay them off sucks. It does. I don't think an expanding monetary system is the way to tackle that issue.

So, how do we deal with the private bank loan interest payments? Would you reform the banking system? If so, how? If someone borrows money, from a bank, out of thin air — thereby creating money that doesn't exist yet in the private sector — how do they pay it all back, plus interest, if it requires more money than currently exists in the private sector? The only way to do that without increasing the money supply is with a high velocity of money (moving money back and forth between debtors and creditors). People have to pay a nominal fee that nets a larger sum than the amount they borrowed. It's not easy to do.

The only reason why people face such a debt burden is because monetary expansion bamboozled people into creating debt fueled asset bubbles.

Yes... that's one reason why we face such a huge private debt burden right now. It was bad policy. Though, I believe a lot of that debt expansion was private debt expansion. But, I certainly see that side of your point.

Unless you are advocating an accelerating rate of inflation for house prices zooming off to ever new multiples of peoples wages you are going to bump into that issue. Price stability would mean that people would only buy houses that they could afford and that would put a ceiling on prices. Germany and Switzerland had stable house prices. They now don't have a housing crisis.

Interesting... so, are Germany and Switerland able to keep their base money supply from increasing? I'm having trouble seeing how they can prevent the base money supply from increasing if there are private interest payments that need to be made and the velocity of money isn't always high or new loans aren't always being created.

I'm just confused as to how you deal with the private interest payment spiral. How do people not default on the interest payments, without new money, if the economy isn't going perfectly smoothly? And once you introduce new base money, how does that not create a deficit spiral without flooring interest rates to zero? (which is an option). I just think I need you to explain how you deal with private and public interest payment spirals.

[stone]

Gumby, it was simply cultural factors not monetary factors that prevented a house price bubble and burst in Germany and Switzerland. My point was simply that in those places that didn't have the bubble in the first place, they don't now have a problem.

There also wasn't a house price bubble in Japan this time around. I guess the memory of their previous bubble was still raw. But German and Japanese money was used to fuel the US, UK and Irish etc bubbles. I guess the USA, UK, Ireland etc will now be scared off having a house price bubble until memory fades of the last one. Monetary expansion doesn't make any particular bubble inevitable it just makes some sort of bubble an accident waiting to happen.

A system based around usury basically mathematically doesn't add up as you point out. If you try and wriggle out of that reality by attempting to mirror the compounding interest repayments with  monetary expansion then the consequence is an explosive take over of the economy by usury. Rather than having companies being 100% equity owned, they end up having wafer thin equity with most of the enterprise cost being debt. That causes totally unnecessary bankcruptcies etc as good companies have a hiccup in cash flow and mis a debt repayment. It also means that companies can not afford to innovate as they need to stick to what they know will give the steady income needed for debt servicing. People who make bank loans need to realize that whatever is funded will need to do especially well in order to be able to repay a loan with interest.

People need to realize that certain enterprises need to be financed with repayment as a profit share not as fixed interest (ie by equity finance). In terms of consumer credit- basically it doesn't make sense to charge interest for it. If you have cars to sell and no one can buy them out right then you are going to have to sell them via interest free repayments or not at all.  Stable prices would make car sales people more willing to do that. Currently the fear is that the interest free repayments would not amount to the future costs of producing future cars.   

[Gumby]

A system based around usury basically mathematically doesn't add up as you point out. If you try and wriggle out of that reality by attempting to mirror the compounding interest repayments with  monetary expansion then the consequence is an explosive take over of the economy by usury. Rather than having companies being 100% equity owned, they end up having wafer thin equity with most of the enterprise cost being debt. That causes totally unnecessary bankcruptcies etc as good companies have a hiccup in cash flow and mis a debt repayment.

Right. Supposedly 9 out of 10 restaurants fail in New York City. They can't meet the rent, food and employment payments if they aren't doing really well. That's the nature of debt-fueled capitalism. It's not perfect, and it causes a need for more money.

People need to realize that certain enterprises need to be financed with repayment as a profit share not as fixed interest (ie by equity finance).

Yep. Angel investing and Venture capital. I'd guess many restaurants can't get those kinds of terms. Some might not even prefer it. I think it would be difficult to get the entire private sector on board with that approach.

In terms of consumer credit- basically it doesn't make sense to charge interest for it. If you have cars to sell and no one can buy them out right then you are going to have to sell them via interest free repayments or not at all.  Stable prices would make care sales people more willing to do that. Currently the fear is that the interest free repayments would not amount to the future costs of producing future cars.

Right. So, it sounds like you'd have to drastically change the way people think about credit in order to prevent a constant increase in the money supply. Not saying it can't be done. Just seems difficult and/or impossible given the way the world works right now (debt-fueled bubbles and all).

[stone]

Gumby, people get upset when their team gets relegated from the football league. Is the solution to just expand the league with each new entry so as to avoid any relegation? If people want to start up restaurants that no-one wants to eat in, then more fool the people who lend them money and don't see it repaid. I really don't think it makes sense to try and fix a real problem (such as people who can't cook starting restaurants) by having some monetary system that makes empty restaurants "profitable". I mean where does it end? How much unsold food do you want thrown away?

[Gumby]

Gumby, people get upset when their team gets relegated from the football league. Is the solution to just expand the league with each new entry so as to avoid any relegation? If people want to start up restaurants that no-one wants to eat in, then more fool the people who lend them money and don't see it repaid. I really don't think it makes sense to try and fix a real problem (such as people who can't cook starting restaurants) by having some monetary system that makes empty restaurants "profitable". I mean where does it end? How much unsold food do you want thrown away?

Those 9 out of 10 restaurants don't fail because the food sucks. Most fail because the rent is too high, or the food's too expensive, or the location isn't ideal. There are plenty of restaurants with bad food that do quite well. Besides, if you were doling out loans, how would you know which 1 of the 10 restaurants was going to be successful??